(The following commentary is a summary of discussions among members of the Breckinridge Capital Advisors Investment Committee as they reviewed monthly activity in the markets and investment returns. The members of the Investment Committee, under the leadership of Co-Chief Investment Officers Matthew Buscone and Jeffrey Glenn, CFA, are Co-Heads of Research, Nicholas Elfner and Adam Stern, J.D., M.P.A.; and Portfolio Manager and Director, Corporate Research, Josh Perez, CFA.)

Market Review

After more than a year on-hold, the Federal Reserve (Fed) cut interest rates by 50bps in mid-September, a mild surprise to economists who had been predicting 25bps.

Fed Chair Powell explained the 50bps cut in three ways: 1) Concern about not only the unemployment rate but also the recent slow pace of job growth, 2) Five months of inflation readings without any single readings as high as the increases in Q1 2024, and 3) That a cut would have occurred in July if the Fed had the benefit of knowing July employment data, which was released two days after that month’s Federal Open Market Committee (FOMC) meeting.

The Fed projects cuts of 50bps by the end of the year. Chair Powell suggested the Fed could cut rates faster if economic data worsen in the months ahead. Based on its September Summary of Economic Projections (SEP), the Fed estimates real gross domestic product (GDP) growth will be 2 percent in 2024, 2025 and 2026. Inflation is expected to end 2024 at 2.6 percent and fall to 2.2 and 2.0 percent in 2025 and 2026, respectively, based on the September SEP updates.

In September, Treasuries yields declined by 28, 14, 12, and 8bps for 2-, 5-, 10-, and 30-year maturities, respectively (See Figure 1). With the Fed’s first rate cut since March of 2020 in place and signals of more to follow, bond market volatility trended lower and the 200-day moving average fell, as measured by the Intercontinental (ICE) Bank of America/Merrill Lynch Option Volatility Estimate (MOVE) Index⁶ (See Figure 2). The Treasury Index gained 1.20 percent, 4.74 percent, and 3.84 percent for the month, quarter, and YTD periods ended September 30, 2024, respectively.

The Breckinridge Investment Committee (IC) expects two more interest rate cuts in 2024. The IC’s base case remains for slowing growth due to the lagging effect of tight Fed policy that has impacted small businesses and lower-income households.

Municipal Market Review

According to The Bond Buyer, supply remained at record-setting volumes and demand kept pace with inflows into mutual funds, ETFs, and SMAs, according to Lipper. Municipal yields dropped by 9 and 10bps at 2 and 5 years, and 7 and 10bps at 10 and 30 years. The curve continued to steepen from 5 to 10 years (See Figure 3). Municipal/Treasury (M/T) Ratios (See Figure 4) changed only marginally over the month.

The Bond Buyer reported, “Bond volume in 2024 is on pace to break previous issuance records, as September marked another high-volume month.” 

The report attributed accelerated issuance to “dwindling pandemic aid and election uncertainty,” which prompted issuers to come to market. Issuance rose 44.5 percent to $44.6 billion in September year-over-year (Y/Y). Supply of $380 billion YTD is just shy of 2023's full-year total of $384.7 billion. The record high supply was 2020’s total of $484.6 billion. 

Every week during the quarter saw positive flows to municipal bond funds, totalling more than $8 billion for the quarter and nearly $4 billion in September alone. 

The BBG Managed Money Short/Intermediate Index⁷ added 0.72 percent for the month, 3.05 percent for the third quarter, and 1.20 percent YTD. The BBG 1-10 Year Blend Municipal Bond Index⁸ was up 0.72 percent, 2.67 percent, and 1.87 percent for the same periods, respectively. BBG reported bonds with longer maturities outperformed those with shorter maturities. Only four basis points separated performance among the four categories of investment grade municipal bonds (AAA, AA, A, and BBB), as bonds rated AAA and A added 1.01 percent compared with bonds rated AA (0.97 percent) and BBB (0.99 percent).

During the month, Breckinridge extended duration of intermediate and limited strategies by adding to bonds with a duration of 7 to 8 years to take advantage of higher yields, the steeper curve, and attractive ratios. 

Corporate Market Review

The BBG U.S. Corporate IG Index⁹ gained 1.77 percent, 5.84 percent, and 5.32 percent the month, quarter, and year-to-date (YTD) periods ended September 31, 2024, respectively. The U.S. Corporate IG Index OAS was 89bps at September 30, tightening 4bps for the month.

According to BBG data, the best-performing sectors in September were Electric Utilities, Railroads, Natural Gas, Life Insurers, and Wirelines. The worst-performing sectors were Automotives, Exploration & Production, Oil Field Services, Refining and Supranationals. 

BBG reported that corporate bonds rated A fared the best across the IG quality spectrum, with an excess return of 0.52 percent for the month. On a total return basis, corporate bonds rated AAA were the strongest performers at 2 percent for the month. Long corporate bonds with maturities of 10 years and longer were the best performing segment of the curve on a total and excess return basis.

The corporate bond market also has experienced high levels of issuance during the first three quarters of 2024, per BBG data. Total fixed-rate, gross IG supply in excess of $1.5 trillion through three quarters, already exceeded 2023’s 12-month total issuance of about $1.4 trillion. A resurgence in merger and acquisition (M&A) activity is integral to the issuance of more corporate bonds supporting M&A deals, JP Morgan said.

In September, after redemptions of about $111 billion, net issuance was about $89 billion, BBG reported. Through September 25, about $32.6 billion flowed into long-term taxable bond mutual and exchange traded funds (ETFs) during the month, per the Investment Company Institute.

JPMorgan estimates that about 16 percent of IG corporate bonds issued this year will likely be bonds supporting M&A deals, which would be the highest M&A issuance since 2018.

Fundamentals for IG corporate bond issuers appear favorable entering the fourth quarter, in our view. Rating agency upgrades for U.S. IG corporate issuers exceeded downgrades by about 3:1 through three quarters. 

Securitized Market Review 

Based on BBG data, securitized bonds delivered positive total returns in September, in the third quarter and for the YTD periods ended September 30, 2024. Excess returns were positive for all periods in all sectors except MBS, which was off by 2bps in September.

MBS performance in September was most favorable for conventional¹⁰ mortgages with coupons in the 2.5 percent to 4 percent range, BBG reported. Among Ginnie Mae¹¹ mortgages, those with coupons in the 3.5 percent to 4.5 percent range performed best during the month.

In the ABS sector, per BBG, YTD volume was nearly $273 billion by the end of the quarter, up 28 percent compared with the comparable period in 2023 and a record versus comparable periods in all prior years.

Equity Market Review 

The S&P 500 Index earned a positive return of 2.1 percent for the month, 5.9 percent for the third quarter, and 22.1 percent for the YTD period ended September 30, 2024.

The Chicago Board Options Exchange (BoE) Volatility Index¹⁵ (VIX) moved up as the Fed’s September meeting approached, then receded before increasing as the quarter closed as the market appeared to balance the potential for more Fed cuts alongside a slowdown in consumption and news of measures in China intended to stimulate the economy. The 200-day moving average increased marginally (See Figure 5).

The Russell 1000 Value Index¹⁶ gained 1.4 percent while the Russell 1000 Growth Index¹⁷ gained 2.8 percent for the month, as investors moved away from some defensive positioning.

Based on other factor-based performance data per BBG, investors saw stocks considered to be High Beta—potentially more volatile than the broader market—and High Leverage—a gauge of the level of a company’s capital that is attributable to debt—also performed well during September, with the Fed rate cuts and expectations for further easing.

For September, sector total returns, per BBG, showed positive returns from Consumer Discretionary (up 7.09 percent), Utilities (up 6.60 percent), Communication Services (up 4.63 percent), Industrials (3.39 percent), Real Estate (up 3.31 percent), Materials (up 2.63 percent), Information Technology (up 2.49 percent), and Consumer Staples (up 0.90 percent). Three sectors had negative returns: Energy (down 2.68 percent), Health Care (down 1.68 percent), and Financial Services (down 0.55 percent).

According to BBG, analysts expect earnings to increase 13.7 percent in 2025, which is compared to an expected growth of 9.1 percent in 2024 and realized earnings growth of negative 1 percent in 2023.

We view valuations as rich at approximately 1.5 standard deviations above the average level over the past 30 years. Despite elevated valuations, investors continue to invest in equities. U.S. equity ETF inflows were 47 percent higher quarter over-quarter and 124 percent higher year-over-year, as of September 30, 2024, according to BBG.

[1] The Bloomberg Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year.

[2] The Bloomberg U.S. Treasury Bond Index is an unmanaged index of prices of U.S. Treasury bonds with maturities of 1 to 30 years. You cannot invest directly in an index.

[3] The Bloomberg U.S. Corporate IG Bond Index is an unmanaged market-value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more. You cannot invest directly in an index.

[4] The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. Itis a market-value-weighted index with each stock’s weight in the index proportionate to its market value. You cannot invest directly in an index.

[5] FTSE Russell, a subsidiary of the United Kingdom-based London Stock Exchange Group, produces, maintains, licenses, and markets stock market indices.

[6] The Intercontinental Exchange (ICE) Bank of America/Merrill Lynch Option Volatility Estimate (MOVE) Index measures U.S. interest rate volatility by tracking the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries. Historically, the index rises as concerns grow that interest rates are moving higher. You cannot invest directly in an index.

[7] The Bloomberg Municipal Managed Money Short/Intermediate Index measures the performance of the publicly traded municipal bonds that cover the USD-denominated short/intermediate term tax-exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. It is rules-based, and market-value weighted. You cannot invest directly in an index.

[8] The Bloomberg Municipal 1-10 Year Blend (1-12) Year Index measures the performance of short and intermediate components of the Municipal Bond Index — an unmanaged, market value-weighted index which covers the U.S. investment grade, tax-exempt bond market. You cannot invest directly in an index.

[9] The Bloomberg U.S. Corporate IG Bond Index is an unmanaged market-value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more. You cannot invest directly in an index.

[10] Conventional MBS are issued by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC).

[11] Ginnie Mae MBS are issued by the Government National Mortgage Association (GNMA).

[12] The Bloomberg MBS Index tracks agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by government-sponsored enterprises (GSEs) Government National Mortgage Association (Ginnie Mae) (GNMA), Federal National Mortgage Association (Fannie Mae) (FNMA), and Federal Home Loan Mortgage Corporation (Freddie Mac) (FHLMC). The index is constructed by grouping individual pools into aggregates or generics based on program, coupon, and vintage. You cannot invest directly in an index.

[13] The Bloomberg U.S. CMBS Investment Grade Index measures the market of U.S. Agency (GNMA, FNMA, and (FHLMC) and U.S. Non-Agency conduit and fusion CMBS deals with a minimum current deal size of $300mn. You cannot invest directly in an index.

[14] Bloomberg U.S. Asset-Backed Securities (ABS) Index is the ABS component of the Bloomberg U.S. Aggregate Bond Index, a flagship measure of the U.S. investment grade, fixed-rate bond market. The ABS index has three subsectors: credit and credit cards, autos, and utility. You cannot invest directly in an index.

[15] The Chicago Board Options Exchange (OEX) Volatility (VIX) Index is the ticker symbol and name for the Chicago Board Options Exchange's (CBOE) Volatility Index, a measure of the stock market's expectation of volatility based on S&P 500 index options. You cannot invest directly in an index.

[16] The Russell 1000® Value Index is an unmanaged market capitalization-weighted index of value-oriented stocks of U.S. domiciled companies that are included in the Russell 1000 Index. Value-oriented stocks tend to have lower price-to-book ratios and lower forecasted growth values. You cannot invest directly in an index.

[17] The Russell 1000® Growth Index is an unmanaged market capitalization-weighted index of growth-oriented stocks of U.S. domiciled companies that are included in the Russell 1000 Index. Growth-oriented stocks tend to have higher price-to-book ratios and higher forecasted growth values. You cannot invest directly in an index.

BCAI-10042024-rz1w5ofc (10/8/2024)

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